Should You Cut The Delegation Clause From Your Arbitration Agreement?

A recent report showed that less than half of arbitration agreements in the consumer financial arena include delegation clauses in their arbitration agreements. Two recent decisions from state high courts suggest that is a wise decision because courts do not like to enforce delegation clauses. (Reminder: a delegation clause gives the arbitrator explicit authority to decide issues of substantive arbitrability that would otherwise be decided by a court, like the enforceability and scope of the arbitration clause.)

In Schumacher Homes of Circleville v. Spencer, __ S.E.2d.___, 2015 WL 1880234 (W.Va. 2015), the highest court in West Virginia refused to enforce the parties’ delegation clause. The construction contract contained an arbitration agreement, which stated that “The arbitrator(s) shall determine all issues regarding the arbitrability of the dispute.” When the homeowners sued over construction defects, the builder moved to compel arbitration. The trial court denied the motion, finding the arbitration clause unconscionable. On appeal, the builder focused on the delegation clause, arguing that the trial court erred in not sending the unconscionability issue to the arbitrator.

The West Virginia Supreme Court of Appeals called the rule in Rent-A-Center, that delegation clauses must be enforced unless the plaintiff alleges the clause itself is unenforceable, “absurd” and an “ivory-tower interpretation of the FAA.” Yet, it also recognized the rule is binding on state courts, so it found a different basis to object to the delegation clause. Noting that delegation clauses must be “clear and unmistakable,” the court found that “arbitrability” is an ambiguous term, so the delegation clause here did not clearly delegate the question of unconscionability to the arbitrator. (It did not help that the builder first raised the delegation clause orally after the issues were briefed in the trial court.) One justice dissented from the opinion, calling it “blatant ‘judicial hostility’ toward arbitration” and noting that the court “has been notoriously chastised by” SCOTUS for singling out arbitration agreements for hostile treatment.

[Editor’s note: The decision in Circleville reiterates the need for this blog to exist and continue educating people about arbitration law. The opinion starts by explaining that the SCOTUS decisions construing the FAA “create an eye-glazing conceptual framework” that is “a tad oversubtle for sensible application” and that “the rules derived from these decisions are difficult for lawyers and judges—and nearly impossible for people of ordinary knowledge—to comprehend.” That’s why I’m here, folks! To stop your eyes from glazing over and help lawyers and judges and “ordinary” people understand the FAA. Okay, back to our regular program.]

The Supreme Court of Kentucky did something similar in Dixon v. Daymar Colleges Group, LLC, __S.W.3d__, 2015 WL 1544450 (Ky. 2015). The single-page student enrollment agreement at issue in that case had an arbitration agreement on its back side, with a clause saying “all determinations as to the scope or enforceability of this arbitration provision shall be determined by the arbitrator, and not by the court.” After the students brought suit, the college moved to compel arbitration. The trial court denied the motion, finding the arbitration agreement was unconscionable. The Court of Appeals reversed, finding no unconscionability.

The state supreme court applied the FAA, but found a way out of Rent-a-Centerby reframing the issue as not one over the enforceability of the delegation clause, but instead whether the parties formed an arbitration agreement at all. Because the students argued that their signature was only on the front side of the agreement, and they were fraudulently induced to sign the agreement, the court defined this as a formation dispute that belonged in the courts. Applying Kentucky’s Statute of Frauds, the court held that the signatures had to be at the end of the document and because they were not, the parties were not bound by the arbitration agreement that appeared after the students’ signature.

In drafting arbitration agreements, we must take it as a given that there will be state courts that are hostile to arbitration and eager to find ways not to enforce an arbitration agreement. That is likely exactly the sentiment that led drafters to invent delegation clauses in the first place – hoping that if the very validity of the arbitration agreement could be decided by the arbitrator, there was a higher chance of the arbitration agreement’s survival. However, if the delegation clause is not likely to be enforced anyway, it bears reconsidering its insertion. Reading these two opinions, it strikes me that the argument over enforcing the delegation clause, which involves arguing over Rent-A-Center, may instead remind some judges exactly why they dislike federal arbitration case law so much and give them extra incentive to throw out the arbitration agreement.

Liz Kramer is a shareholder at Leonard, Street and Deinard, one of the largest law firms in Minnesota, where she litigates complex business and construction disputes. Liz graduated from Yale Law School and is deeply knowledgeable on arbitration law. Website: www.arbitrationnation.com